The curious case of foreigners selling Sri Lankan bonds

The continuous selloff of domestic government bills and bonds by the foreigners is difficult to justify at a time when Europe and Japan offer negative rates, whereas Sri Lanka offers 12 percent for treasury notes, according to an economist. “In an environment where interest rates are negative in Europe and Japan, capital should not be leaving the country when the domestic government securities (GSECs) are yielding 12 percent,” said JB Securities (Private) Limited Managing Director and economist Murtaza Jafferjee in a recent note. Sri Lanka’s five-year bond was quoted between 12.10/50 last week while the 12-month treasuries hit 10.60 percent on March 21 — yield rising 90 basis points — one of the highest single-day spikes seen in the history of the market. The yield on the benchmark US 10-year note has been losing lately and offers around 1.873 percent.

The Federal Reserve’s March monetary policy sounded dovish and retreated from expectations of four rate hikes in 2016 due to uncertain global environment and weak inflation. This demonstrates a considerable margin an investor could enjoy by investing in Lankan government bonds even after pricing in the risk premium for weakened Lankan sovereign and foreign exchange volatility. However, Jafferjee said what is required is to show a credible path for fiscal discipline to convince these investors instead of confusing the markets by conflicting statements made by different organs of the government.

“What is needed is a demonstration of credible fiscal consolidation measures by speedily implementing the Prime Minister’s proposal of a VAT increase from 11 percent to 15 percent and increasing concessionary rates of corporate taxes to 17.5 percent,” he added. Unlike in the past, excess imports did not act as a primary casual factor for Sri Lanka’s this time balance of payment (BoP) crisis as the lower crude imports bill gave space. Instead, the continuous outflows of short-term foreign capital from the government treasuries triggered the crisis and the repayment of loans compounded the problem.

The bond holdings by the foreigners came down by Rs.219 billion or 48 percent during the last 15 months and the total stock of treasury bills and bonds held by the foreigners by March 16, 2015 was Rs.238 billion, the Central Bank data showed (see illustration).

Besides, there are estimated US $ 4.5 billion worth of foreign currency loan repayments lined up during the next 12-months but the gross official reserves by the end of February remained at US $ 6.5 billion. Sri Lanka this month received US $ 700 million through a swap agreement with the Reserve Bank of India while another one for US $ 1 billion is planned with China. But economists say such short-term fixes would not suffice. Hence, Sri Lanka is now negotiating a bailout package of up to US $ 1.5 billion from the International Monetary Fund (IMF) — likely to be drawn by mid April — to come out of the existing BoP crisis created as a consequence of relaxed monetary policy to spur growth and freebies given to garner votes from the masses.